Yield direction and volatility
Yields crept higher over the week, but reversed direction on Friday after US payrolls increased less than economists had expected for March. The market was expecting more than the 192,000 jobs that were added in March, dampening speculation the Federal Reserve will speed up cuts to its stimulus program. In response a risk-off session followed, with the 5 and 10 year benchmark swap rates slightly lower by 1-2 basis points (bps) over the week, closing the week out at 3.72% and 4.45% respectively. The 5 and 10 year Commonwealth government yields lowered 4-7 bps to finish the week at 3.48% and 4.15%.
The March employment situation in Australia will be announced tomorrow morning, with expectations for a very modest 2,500 jobs being added and an unemployment rate slightly higher at 6.1%. It is highly unlikely for interest rates to move higher until the unemployment rate reverses its upward trend; however, if 1st quarter 2014 inflation figures, due out on 23 April, are as high as the previous quarter (2.7% year-on-year increase) this decision will become increasingly complicated for the Reserve Bank.
Investors should maintain exposure to BBSW and CPI
Interest rates and inflation are at an interesting junction in Australia, with the cash rate sitting at 2.50% and the RBA target inflation rates being the same. While interest rates are more volatile than inflation, if rates and inflation are expected to remain constant over the medium term then it is worthwhile looking at spreads of fixed income products that are based on each.
Floating rate notes pay interest as a margin over the bank bill swap rate (BBSW) and inflation linked products pay interest as a margin over the consumer price index (CPI), but the CPI margins (Figure 1) offered on the inflation linked products are currently significantly higher than the margins to BBSW (Figure 2).
Figure 1
Figure 2
Investors with a view that both of these variables (BBSW and CPI) are going to remain steady over the foreseeable future would do well to maintain at least as much exposure to inflation linked products as to floating rate notes.
CBL Corporation new issue
A new five year fixed rate bond for New Zealand insurance group CBL Corporation Limited (CCL) was announced on Monday, offering an attractive 8.25% coupon. Investor interest was very strong, and the deal closed fully subscribed on Tuesday. As is typical, the coupon rate was set at a level attractive enough to ensure successful placement and the security is likely to trade at a premium when secondary trading begins on 17 April.
Mackay Sugar now available to retail investors
From Monday, the 05 April 2018 fixed coupon bond issued by Mackay Sugar was approved for distribution to retail investors. This is the second of the issues led by FIIG to be made available to the retail market, with potential more to follow later in the year. Trading at yields around 6.25%, this bond represents one of the few opportunities for retail investors to access yields over 6.00%.
Other credit margins and trading activity
Gradually trading tighter since issuance, the Insurance Australia Limited March 2019 Floating Rate Note (FRN) and Bendigo and Adelaide January 2019 FRN lines came in 4 bps and 2 bps respectively over the week, as demand remained strong for both lines. The margins have crept tighter for these quality offerings since being launched earlier this year, and are expected to tighten further with demand showing no sign of slowing. FIIG still has good supply to both names and is well placed to fill client buy orders.
Activity in the inflation linked sector was very high last week as a number of standout offers from the institutional sector saw clients flock towards the asset type. The Sydney Airport 2020 capital indexed bond (CIB) was the clear favourite. Excellent supply coupled with a very attractive offer level prompted turnover of $11.5m recorded across 113 trades, making it our most heavily traded issue for the week.
Another trade favoured by many clients looking to shorten duration was a switch out of the MPC Funding 2033 indexed annuity bond (IAB) into the shorter dated 2025 line. Both lines have enjoyed good two way flow and FIIG is in a good position to further execute this switch.
FIIG is currently able to source a wide range of inflation linked securities. Some of our favourites that have immediate supply are listed below (indicative offer levels shown).
- Sydney Airport Nov 2020 CIB: 6.40%
- MPC Funding Dec 2033 IAB: 6.12%
- Praeco Aug 2020 IAB: 5.15%
Notes:
Offer levels are indicative as at 08 April 2014 and subject to change based on demand and market movements.
Yields for floating rate notes are estimated as the sum of the swap rate to maturity / call and the trading margin.
Yields for capital indexed bonds and index annuity bonds are estimated as the real yield plus a 2.50% inflation assumption.